Advertising, a contrarian indicator
Resist the urge to buy past returns
I am struck by the number of GIC ads of late by banks and other deposit-taking institutions. They're spinning their ads to play on the emotional pain of stock market losses. History indicates that giving into these ads by forking over some dough could be your worst long-term move.
One ad in my local paper by a credit union shows a frowning man below the caption, "Are you frustrated with your RRSP invested in the stock market?". GIC rates were shown, but only those applicable to investments of $500,000 and up. Sure, it's aggressive marketing but it's really no different than what the mutual fund industry has done throughout the bull market of the 1990s.
It's a well-known phenomenon that investors follow returns. So, it's no surprise that fund companies rushed their top performing funds to prominent ad spots in print media across the country after a hot run. The problem: by the time you see a print ad for an investment that has just posted a year of 30, 50, or 100 per cent returns, it's often the worst time to buy.
At my former job, we studied ads featuring performance through most of the 1990s. The performance quoted in the ad for each fund was compared against the performance of those same funds for the subsequent year.
In all cases, performance dropped off by a full 10 percentage points or more. About 1/4 of the funds studied subsequently underperformed their advertised returns by more than 25 percentage points.
The lesson: financial markets are cyclical by nature. Just when the status quo looks poised to continue forever, that's when a shift begins to occur. And before you know it - and likely before you've made any changes - you'll "see" the shift in trends.
To read more about the study of performance ads, check out this 1998 Globe and Mail article by Duff Young .
Keep performance in perspective
During calendar 2000, mutual fund investors ploughed more than $34 billion into pure stock funds. Interestingly, the sum of net money invested in all other categories was negative to the tune of nearly $1 billion. Of course, it was the spring of 2000 that tech stocks began showing their vulnerabilities; peaking in late summer.
The negative stock returns that began in the latter part of 2000 accelerated in 2001. It became apparent that fund investors were getting nervous, though not panicky since more than $16 billion flowed into funds during the year. Money market funds picked up its largest share of net investments ever while stocks continued to weaken.
So, let's recap quickly. By the time big returns had been posted by the beginning of 2000, investors were piling more and more money into the industry's hottest funds. Maintaining an overly optimistic outlook, the weakness in 2001 caused a slowdown in net investments, but didn't deter new investment.
To that point, certain areas had remained unscathed - i.e. value stock pickers and other defensive funds. But by late spring, May to be exact, the bottom began falling out. As it happens, June was the first of what is now a seven-month streak of net outflows for pure stock funds.
If history is any indicator - and I believe it is where human behaviour is concerned - fund investors will continue to pull money out of stock funds until most of the recovery in stock prices has already occurred. By that time, investors will have seen the attractive returns advertised and want to jump back in.
But I'm afraid that, by doing so, investors will simply be making the same mistakes they've been making for years.
The challenge for investors and their advisors is to base today's investment decisions without the undue influence of the recent past. Last week, I walked through the reasoning of one of the industry's most insightful analysts, and extended his conclusions to a basic, long-term return projection for U.S. stocks.
The greater challenge will be to continue to have a forward-looking focus and realistic expectations - admittedly difficult both in good times and bad.
Recognizing the behavioural patterns that hurt investor returns is the first step to being able to correct that behaviour. It would be a massive understatement to say that such discipline is easier said than done. And it' s fair to say that many people (even many industry professionals) simply don 't have the personalities to consistently implement such a discipline.
But sticking to the basics of diversification and having a plan (i.e. investment policy statement) to use as a reference when considering changes will go a long way toward helping you stay on track.
Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
|Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...|